A German Lesson for Australia – understanding the importance of family businesses

| October 26, 2017

If an after-dinner speaker wants to press the point about the dynamism of capitalism, he or she will probably draw on one of those indicators of Schumpeter’s “creative destruction” such as the fact that out of the companies that made up the Fortune 500 in 1955, only 60 remained in 2016.

At the Global Access Partners 2017 Summit “The future of Australia’s midsize business” the after-dinner speaker, Albrecht von der Hagen, was on a completely different tack. His presentation was about Germany’s Familienunternehmer (literally “family undertakings”) and their role in Germany’s economy.

It’s a fair bet that of the Familienunternehmer that existed in 1955, most are still in business two generations later in 2016.

As he explained, they are financially conservative:

Quite often, the family-entrepreneur decides differently than what the stock markets or analysts would predict. Unlike public companies, family entrepreneurs don’t base their decisions on quarterly-results but rather on long-term strategies for generations. A further point in which they differ from public companies is the equity-ratio. On average all public companies in Germany have an equity-ratio of 36 percent.

But that doesn’t mean they are conservative in their technologies or business practices. Some grow to be large enterprises. The Miele and Zinkann families, for example, founded the appliance manufacturer Miele in 1899, and they are still own it. In Australia the most prominent Familienunternehmer is probably the supermarket chain Aldi.

For the most part however, the Familienunternehmer retained earnings go into strengthening the firm’s business. They’re in it for the long haul, and that means having the resources to ride out recessions and other disturbances. (Once, on a holiday in Thüringen, in the former East Germany, I was chatting with our host, the owner of the hotel in which I was staying. Without any hint of irony he said “Apart from a few disruptions between 1933 and 1989, the business has been in the family’s hands for 300 years”.)

Germany was hit by the 2008 financial crisis, but many small and medium-sized businesses rode it out by what they call Kurzarbeit – cuts all around to wages, salaries and owners’ drawings. That reflects both a culture of shared sacrifice, and a hard-nosed realisation that sacking people is a huge loss of a firm’s most valued capital, its human capital.

Albrecht von der Hagen went on to talk about “Hidden Champions”, firms that achieve market success with niche products. They are mostly from the mechanical engineering and electrical industries, but he mentioned as an example a firm that specialises in curtains for opera houses and theatres. There are German firms manufacturing and exporting products which one would assume to have shifted offshore many years ago, including flexible dog leashes and boots for mountain climbers.

Competitiveness in such firms is not just about labour and other direct manufacturing costs (an obsession of some of our business lobbies), but also about the strength of a firm’s less tangible assets, including customer and employee loyalty, relationships along the supply chain, and the firm’s reputation for quality and reliability.

Such firms’ market strength is often based on specialisation areas where potential competitors would face a steep and long learning curve. Even with easy access to finance and an easy supply of labour it is difficult for a newcomer to get into dyes, brewing, metallurgy, machine tools, luxury cars or even opera curtains – all areas of German strength. In this regard, the areas of German specialisation are quite different from the IT-intensive areas that characterise the Silicon Valley model of capitalism, where the duration of competitive advantage is measured in months rather than years or generations.

Australia, which is so heavily dependent on basic commodities for export earnings, is battered by exchange rate movements. While we have plenty of very small private companies, we could do well with more mid-sized private companies that aren’t dependent on a ratty stock exchange or our real-estate obsessed banks for finance capital.

In part there is a problem in our tax system, particularly the government’s decision in 1999 to abolish indexation of capital gains for taxation valuation: even though the rate of tax was reduced the absence of indexation means that after twenty or thirty years taxation is applied to fictitious nominal gains.

But there also seems to be a cultural problem in Australia, conditioned by more than two centuries of easy profits in what Ian McLean in his book Why Australia prospered calls a “settler society” economy. Ever since the NSW Rum Corps cornered the liquor market Australia has been the country of quick profits – by taking land from the original owners, by overstocking and depleting our fragile soils, by finding gold, iron or coal, by speculating in land in our fast-growing cities, by getting an early look-in on a privatisation or IPO, or by seeking and obtaining a protective tariff, an exemption from competition laws or other forms of economic rent.

We have been conditioned to expect quick profits.  Over the period 1900 to 2017, of the 24 countries in the Credit Suisse database of long-term returns on equity, Australia is pipped only by South Africa – another “settler society”. Our real return at 6.8 per cent compares with 3.3 percent for Germany.

Investors in our public companies expect quick returns, and if the directors of those firms cannot find anything that clears their high hurdle rates they pay out their profits as high dividends, capital buy backs and high executive salaries. Households, encouraged by the same capital gains tax regime that discourages patient long-term investment, channel their savings into real-estate speculation. Our small business sector grizzles about the Opposition Labor Party’s proposal to crack down on family trusts as a means of drawing tax-free funds from family companies: in contrast to the German Familienunternehmer tradition in Australia a small business is often seen as a convenient cash cow, or, if it is fattened up with retained earnings, that is often with an objective to seeing it sold to a public company. Dividend imputation, a sensible reform designed to establish tax neutrality between corporations and individuals and to encourage recycling of funds from mature established firms to newer growing firms, has become a means of drawing down even more corporate profits into consumption.

Tweaks to our tax system may do something to encourage mid-sized companies, but public policy can only go so far. We need a cultural change, an understanding of what constitutes realistic and sustainable investment returns, an understanding of the difference between making money and creating wealth. Can we achieve that change in culture without having to undergo the pain of a deep recession at the end of a 229 year boom?